Page 237 - TaxAdviser_2022

domestic eligible corporation that does
S Corporations not have more than 100 shareholders, Approval of an
any shareholders that are not individuals
Tax planning and (except for certain trusts, estates, and S election by the
considerations: S corporation exempt organizations), or shareholders IRS and/or a state
targets who are nonresident aliens. Addition-
Merger-and-acquisition (M&A) activi- ally, the corporation cannot have more jurisdiction does
not mean that S
ties have not slowed down during the than one class of stock. When a small
past few years, including during the business corporation chooses to become corporation status
COVID-19 pandemic. From govern- an S corporation for federal income tax
remains safe and
ment lockdowns to labor shortages, purposes, it must file an election with
rising inflation, and other events, the the IRS using Form 2553, Election by a sound forever.
pandemic has taken a toll on businesses. Small Business Corporation.
M&A markets, however, have continued Upon processing the election applica-
to thrive as long as the price and, ulti- tion, the IRS will issue a CP261 notice
mately, the structure is right. S corpora- confirming its approval of the S election path when structuring the acquisition
tions have been a popular entity choice on the identified effective date. Certain of the S corporation target. Buyers may
for closely held and operated small busi- state jurisdictions require an indepen- acquire an S corporation in many ways.
nesses and, more importantly, have been dently filed S election application; state Below are three basic scenarios for ac-
targets in many M&A transactions both S corporation election procedures vary quiring an S corporation target.
pre- and post-COVID-19. from state to state. Owners of S corpo- Scenario 1: A potential buyer
A “small business corporation” can rations should maintain documentation meets the definition of an eligible share-
elect S corporation status for federal proving the validity of the S corporation holder under Sec. 1361(b) and acquires
income tax purposes. Sec. 1361(b) de- status by maintaining the executed fed- the stock of the S corporation from the
fines a small business corporation as a eral election, the CP261 notice, and any existing shareholder(s).
state S corporation election documenta- Scenario 2: A potential buyer is an
tion in their permanent files. ineligible shareholder and attempts to
Approval of an S election by the negotiate with the seller(s) to either ac-
IRS and/or a state jurisdiction does not quire the assets of the business or, alter-
mean that S corporation status remains natively, acquire 100% of the stock of the
safe and sound forever. The rules and S corporation with a Sec. 338(h)(10) or
requirements under Sec. 1361(b) must Sec. 336(e) election, resulting in deemed
be adhered to from the effective date of asset purchase and sale treatment.
conversion to S status until the company Scenario 3: A potential buyer is an
no longer desires to be an S corporation. ineligible shareholder and is concerned
Thus, if the company always intends about the S status of the target for a va-
to be treated as an S corporation, it riety of reasons. Accordingly, the poten-
must always follow the rules under Sec. tial buyer opts for the seller to perform
1361(b). The moment the company ad- pre-planning F reorganization steps,
mits an ineligible shareholder or creates which ultimately leads to converting the
a second class of stock, the S status is in target into a disregarded entity (DRE)
jeopardy and will most likely terminate, under Regs. Sec. 301.7701-3(b)(1)(ii)
at which point the company becomes a that is owned by a newly formed S cor-
poration. This scenario is also commonly
C corporation for tax purposes.
PHOTO BY SHELLY STILL/ISTOCK tion’s S status is uncertain (e.g., the remain a minority interest owner in
Where the validity of a corpora-
used when a buyer wants the seller to
the business by rolling over a portion
CP261 notice is not available, or activity
between the S corporation and its share-
of the seller’s existing equity while the
buyer obtains a stepped-up basis in the
holders reflects that there might be more
underlying assets. This scenario follows
than one existing class of stock) a poten-
tial buyer may want to choose a different
the guidelines set forth in Rev. Rul.
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